OPEC can't get over its cheating problem

OPEC’s monthly report for February was released Tuesday
morning, and total output appears to have fallen from 32.097
million bpd in January to 31.958 million bpd. Members which
agreed to the production freeze and cuts were able to reduce
production from 29.9 million to 29.7 million bpd, with Iraq and
the UAE continuing to pump above agreed-upon levels, exceeding
quotas by 63,000 and 51,000 bpd, respectively.

This is pretty good news, but in light of last week’s massive
U.S. inventories and the subsequent decline in prices from $54 to
$47, the report isn’t enough to indicate a reversal in OPEC’s
suddenly declining fortunes.

Secondary source verification indicated that Saudi production
continued to fall, to 9.797 million bpd. According to direct
communication, rather than continue its cuts, the country
actually increased production between January and February, from
9.748 million to 10.011 million bpd.

While total Saudi output has fallen significantly since last
year, by as much as 450,000 bpd, the monthly data would indicate
that further deep cuts by OPEC’s leading producer are unlikely,
at least until a new agreement is reached. Saudi Arabia has
shouldered much of the burden of the OPEC cuts, but at last
week’s CERAWeek 2017 conference, the national energy minister
indicated that Saudi Arabia would be unwilling to continue cutting its own
production just to give a boost to prices: it would take more
concerted action by OPEC to achieve that goal.

American production also spiked after the deal was announced,
rising above 9 million bpd, and the increases are likely to
continue. The EIA estimates that U.S. shale drillers will
increase production by 109,000 bpd in April, with the most
significant rises coming from the Permian and Eagle Ford fields
in Texas and New Mexico.

OPEC datasuggests that world oil supply
has fallen since November, from over 98 million bpd to 94.9
million bpd, with a decline of 200,000 bpd coming in February.
This would indicate that the cuts by OPEC and non-OPEC producers
have largely left their mark, that production will only rise from
here, and that the immediate impact of the OPEC deal has been
felt.

Now that the initial impact of November’s agreement to freeze
production seems to have worn off, speculation has begun
regarding OPEC’s next move. The freeze and production cuts
removed about 1.2 million bpd from markets and brought a
tightening of supply, yet this was almost entirely offset by
increases in production from certain OPEC members, including
Iran, which were exempt from the freeze.

The sentiment that OPEC’s outward unity is starting to
crack has contributed to the downward turn in price and the
emerging bearishness surrounding oil futures. Breaks in
OPEC’s show of unity include Iraq’s continued desire to boost
production to 4.5 million bpd. The February report indicated
that it is pumping about 91,000 bpd above the intended quota,
though this is still a reduction from its pre-November
production level of 4.6 million bpd. Yet Iraq, rather than
contribute as Saudi Arabia has done to the overall cuts,
continues to contribute what Riyadh sees as the bare
minimum.

There are also the Russians to consider. Saudi Energy
Minister Khalil Al-Falih expressed his irritation last week
that Russia isn’t doing its part, and that Saudi cuts would
not make room for “free riders” who could profit from higher
prices. Russian cuts contributed to non-OPEC production
decline of 558,000 bpd, but the Russian company Rosneft has
already expressed doubt that the cuts will last
past the six month mark, as was originally intended. The
Russian energy firm has indicated that it feels a real
balance in the market will require action by consumers and
regulators, not just producers, a tacit admission that the
experiment to cut production and bring back high prices
has failed, at least for the time being.

With U.S. shale production likely to boom, Russia on the
fence and OPEC’s leader unwilling to shoulder more of the
burden, the big question facing analysts is what will OPEC do next? While the
settlement of the production agreement last year was a
surprise, additional cuts or a decision to extend the
existing cuts for another six months may be nothing short of
miraculous: if prices stay low, and seem to stay that way for
the immediate future, the temptation by OPEC members to ramp
production back up and take back market share, trying for a
second time to put U.S. shale out of business, will be a
strong one.